Inside the tech divorce of the decade: PayPal and eBay start a new life without each other

eBay CEO John Donahoe was visibly agitated one March afternoon in 2014, as he slowly paced the length of a small conference room at eBay's San Jose headquarters. The 6-foot-5 chief executive was in his usual work uniform — relaxed dress shirt and dark trousers — and that classic, controlled Donahoe 'do: thick hair parted to the right side, evoking a young Ted Kennedy. Only, on that day, the side part wasn't so tidy, the dress shirt not so crisp.

“PayPal has enormous potential, and we are completely capable of driving that potential,” Donahoe told me that March afternoon, waving his arms around, his usually warm manner diluted by defensiveness. He was explaining a diagram showing how eBay and PayPal belonged together because some of eBay's earnings were used to fund PayPal's growth abroad.

Donahoe's presentation that day, which he also made to many investors, went to waste. After earning kudos for one of Silicon Valley's successful turnarounds, Donahoe will step down from his job on July 20 as eBay and PayPal officially separate in the biggest tech divorce of this decade. On Monday morning, investors will be able to buy stock in an independent PayPal that will be worth $40 billion, and eBay will be left to find some new way to compete with rival Amazon. In the past year, the pairing took a beating as eBay and PayPal were plagued by culture clashes, executive departures, and a very public pummeling by one of the wiliest wolves of Wall Street. The result is that, after 13 years together, eBay's separation from PayPal is now a story of snatching defeat from the jaws of victory, a cautionary tale for all innovation-obsessed Internet darlings who forget their other master: Wall Street's insatiable demand for growth.

A tangle with Wall Street's break-up artist

Donahoe, a veteran Bain & Co. executive schooled in the harsh ways of corporate America, didn't need to be a fortune-teller to see it all coming. That March day in his office, Donahoe had a solid reason for being worried: activist investor Carl Icahn was coming for him. Icahn owned 2% of eBay shares, and he was vocally unhappy about the imprisonment of fast-growing PayPal within slower, older eBay. PayPal's mobile payments business is up 40% compared to last year, while eBay, with single-digit growth, struggles not to lose more ground to industry leader Amazon.

“PayPal today just kind of grows,” PayPal cofounder Max Levchin tells Mashable. “I don’t think you have to do that much to show double-digit growth.”

That means the minute Icahn had started complaining about eBay in January 2014, Donahoe must have known he wasn't just facing another unhappy shareholder. He was facing the end of his seven years as CEO at eBay during which he had struggled with culture clashes and executive departures but nonetheless achieved the rare feat of turning around the company's fortunes, restoring its profitability and boosting its stock price to around $66 — more than quintuple their value when he first became CEO. Few would have given Donahoe a failing grade — or walking papers — before Icahn appeared on the scene.

"eBay did something remarkable, which for some reason does not get sufficient credit," a former eBay executive complains. "It turned around an impossible problem. It did come back, and that's thanks to John."

When big-box stores sold out of Beanie Babies or antique shops lacked certain collectibles, shoppers flocked to the auction site.

Image: Associated Press

Capturing 'lightning in a bottle'

French-born Iranian entrepreneur Pierre Omidyar launched AuctionWeb, or what eventually became eBay, in 1995, when Sergey Brin and Larry Page had only just met at Stanford and Facebook CEO Mark Zuckerberg was still in middle school.

"eBay was lighting in a bottle at the time," one former eBay executive tells Mashable. "There were few places to go when the Internet was that early. It was a wünderkind."

eBay quickly joined AOL and Yahoo as one of the top three most-trafficked Internet sites. But eBay steadily fell from prodigy to B student. By 2009, eBay stock had fallen to $10 a share from an all-time high of $58 in 2004. Meanwhile, a terrifying competitor had grown: Amazon's online superstore offered cheap, specific prices rather than squishy time-consuming auctions, selling everything from books to music, videos and electronics with fast delivery.

eBay, under then-CEO Meg Whitman, was struggling, reeling after the disastrous acquisition of Skype, worried about its falling profitability and trying to keep up with consumers' desire for convenience and bargains. With her previous history at Bain, the disciplined Whitman was more focused on hitting certain numbers. Her goals centered on growing annual revenues from $431 million in 2000 to a projected $3 billion in 2005, rather than the Silicon Valley standard of innovation to keep consumers from getting bored.

Ultimately, that meant eBay, which had practically invented online commerce, had trouble keeping up with the market it had created.

Former eBay CEO John Donahoe with former eBay CEO Meg Whitman.

Image: Associated Press/Associated Press

The wave of MBAs

eBay's main problem seemed to be this: it had too few engineers, and too many MBAs.

"eBay didn't promote engineering and design as powerful in the company," one former high-level eBay employee tells Mashable.

The employee says the company prioritized hiring MBAs. "I really thought that in the end, they weren't driving enough innovation on the product side, and I was really pushing for it. I think if we had more of an engineering-driven culture, we could have done that more easily."

Former employees say there were many lost opportunities to modernize eBay. The company's valuable search algorithm, for example, was stored for years in text files easily accessible by select business employees, who could have easily updated search results to prioritize items with higher prices, and in turn, boost company revenues.

When Whitman stepped down as CEO to run for governor of California in 2008, she hand-picked Donahoe, whom she had initially recruited to run the auction business, as her replacement.

Resistance to a new leader

Donahoe was a welcome change to many. If employees saw Whitman as bold and decisive, Donahoe by contrast was warm and approachable. Employees praised his even manner, good memory for personal details, and ability to show genuine interest in people from cab drivers to CEOs.

Donahoe moved quickly to fix eBay with a three-year company plan to combat fraudulent activity — fake merchandise, sellers not shipping items, unpredictable delivery times — by beefing up the customer service and fraud investigation teams. He also pushed for more curation through an update to the site that introduced better search and a Pinterest-like feed that recommended items.

eBay changed its fee structure, which angered the site's vocal sellers. Under the changes, sellers found low fees when listing items, but eBay took a bigger cut if the items actually sold. The site also made a radical change to directly challenge Amazon, offering fixed-price sales rather than auctions. It was a wily business move but alienated some hardcore loyalists. Some created YouTube videos critical of Donahoe.

“They had literally taken clips from the movie Schindler’s List,” Donahoe recalled to students at the University of Texas at Austin. “They took clips of the German guards shooting at Jewish prisoners, and they put my name on the German guards, and they posted Ebay sellers on the Jewish prisoners’ chests.”

He publicly called it a low point, recalling, "I remember sitting in a hotel room that night and thinking, Is this worth it?"

Infusing eBay with a startup ethos

Donahoe's answer to the resistance to a turnaround: new blood. Donahoe started carving out senior roles for startup entrepreneurs. He promoted Jack Abraham, founder and CEO of an acquired startup called Milo, to head up eBay's push into local in 2012, and elevated French entrepreneur David Marcus to PayPal president.

Marcus, then 39, proved one of Donahoe's more controversial appointments. In 2011, eBay scooped up his startup Zong, a mobile payments company focused on online games and social networks, for $240 million. At turns sharp and charming, the salt-and-pepper, Hermes-toting Marcus became a favorite of Donahoe's.

Marcus dove into changing eBay's payments business at a dizzying pace. He led the $800 million acquisition of Braintree, an online payments business that also owns the popular peer-to-peer payments app Venmo. He sought to give PayPal and its 14,000 employees a startup-like atmosphere. Marcus ditched the dense, phone book-like design documents product managers had to draft in order to pitch a new product, tore down most of the cubicle walls at PayPal's San Jose headquarters, and had much of PayPal's underlying technology revamped.

Former PayPal president David Marcus at the SETI institute in Mountain View, Calif. in 2013.

Image: Associated Press

His entrepreneurial gusto also meant coming down hard on people he considered disloyal to the company's mission.

“If you are one of the folks who refused to install the PayPal app or if you can’t remember your PayPal password, do yourself a favor, go find something that will connect with your heart and mind elsewhere,” Marcus wrote in a leaked memo from February 2014.

"Dogfooding," the habit of using your own product, is common practice at many tech companies like Facebook, Apple and Microsoft. In fact, Donahoe had a similar management tactic when he held company meetings, sometimes admonishing workers for using competitors' services like Amazon's more than eBay and PayPal's.

But Marcus's rebukes were more frequent and direct, sources say. Marcus's zealous ways also created friction with several PayPal executives, including vice president of retail Don Kingsborough and Gary Marino, senior vice president of the Americas and global financial services.

"David is a great guy, but he was put in the worst position," one former senior eBay employee said. "He’s a product guy, and he hadn’t really managed any place with more than 250 people. He was thrown to the wolves."

On top of that, although Marcus and Donahoe were close, sources say Marcus was vocal about disagreeing with eBay’s overall strategy. He also didn’t agree with Icahn's idea of spinning off PayPal into a publicly traded company, believing that PayPal needed to go private to escape Wall Street's scrutiny while broadening its ambitions to finally get a banking license, which the company explored on and off over the years.

Still, taking an enormous company like PayPal private would have been wishful thinking, observers say.

"The practicality of taking such a big organization private would be hard," says investment banker Peter Falvey, the founder of Falvey Partners.

It was never fully explored. There was too much else going on. eBay won a brief respite from Icahn in April, but the company continued to face pressure from other shareholders who still carried the banner for Icahn's idea. Even earlier, Marcus began thinking about leaving PayPal and consulted family and friends, according to sources who described him as unhappy. The entrepreneur was used to being more hands-on with product, not running an organization of 14,000. At PayPal, he felt he was spending the vast majority of his time managing people, putting out fires and fighting political battles. So when Facebook CEO Zuckerberg floated the idea past Marcus of running Facebook's messaging products, Marcus eagerly accepted.

PayPal's efforts to modernize under David Marcus included testing face verification.

Marcus's announcement in June 2014 that he would leave was a shock to PayPal employees and a blow to Donahoe, who had seen another of his entrepreneurial hires, Jack Abraham, exit the company the year before to create his own startup.

But Donahoe didn't have time to dwell. The drumbeat for a separation was still growing, this time without Icahn.

"I think the pressure was such that it had to happen," a former eBay executive explained. "This was probably the only way."

Even Donahoe, who had fought the split, seemed resigned about it.

“The synergies which helped fuel [PayPal’s growth] are declining over time,” Donahoe told me last September. "The industry landscape is changing, and each business faces different competitive opportunities and challenges."

An uncertain future

eBay now has to fend for itself, with revenue growth between 3% and 5% for this year — a bump up from its previous predictions of between 0% to 5%, but well behind Amazon's 15%. It doesn't have to funnel time and money into PayPal, but it has bigger problems.

“They’re still going to be under pressure from Amazon and other businesses,” Falvey says.

New eBay CEO Devin Wenig is following Donahoe's career path at the company. He ran the online business, Marketplaces, and rose to the C-suite. He's different from Donahoe. Employees call him “super-sharp” and “shrewd.”

“There’s an efficacy, an empathy and a ruthlessness that is all contained in him in good balance,” one former eBay executive says. “He’s unapologetic about, 'here’s what it takes to succeed.'"

What the separation does is let both sides pursue new partnerships they couldn’t before. PayPal can work with all commerce companies -– yes, even possibly Amazon — and eBay can offer its customers alternative payment providers.

The two ironed out a six-year agreement that preserves a good chunk of the relationship they had before. Under the agreement, 80% of sales from eBay Marketplaces will be routed through PayPal — the same way it worked before the split.

PayPal agreed to pay eBay a commission if its percentage of transactions surpasses a certain mark. PayPal can’t create an eBay-like marketplace to sell physical goods, and eBay can’t create a PayPal–like payments system of its own any time soon.

PayPal president Dan Schulman at a company event in May in San Francisco.

Image: Mashable, JP Mangalindan

PayPal has two major challenges ahead: infiltrating stores, and fending off ubiquitous competitors like Apple and Square.

While PayPal is growing fast in mobile payments, 90% of transactions occur at physical stores — a fact that Apple Pay and Square have jumped on with merchant-friendly software.

PayPal's founder, Levchin, wonders how aggressive PayPal has to be to stay competitive with Apple, Amazon, and Square. (Even Facebook is in the payments game now that you can pay people via Messenger.)

New PayPal CEO Dan Schulman, who spent four years at American Express, plans in part to compete by making it easier for all 169 million PayPal users to make purchases from third-party websites without going through the lengthy process of manually inputting their payment information.

After 2021, the future gets murkier for both sides, especially for eBay, which, even at a $30 billion value, is likely to be acquired, analysts told Mashable. Alibaba is the most obvious one to take a look, analysts say. The Chinese Internet giant has grand ambitions of one day entering — and let’s face it, steamrolling — Western markets, and snapping up eBay is just one way to make that happen. RBC's Mahaney also envisions a giant traditional retail chain — your Wal-Marts or Targets of the world — one day scooping up eBay.

The world's biggest auction business may end up, one day, going to the highest bidder.

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